How to choose between preferred and common stocks: A guide for investors

When you decide to invest in the stock market, you face a fundamental decision: common or preferred shares? Although both represent equity participation, the rights they confer are markedly different. Understanding these differences is crucial to aligning your investment with your financial goals.

The fundamental contrast between preferred and common shareholders

The essential difference lies in corporate rights and return structures. Preferred shareholders receive fixed and priority dividends but cannot vote at meetings. Common shareholders, on the other hand, exercise decision-making power but their dividends fluctuate with company performance.

Common Shares:

• Grant voting rights in corporate decisions
• Variable dividends based on profitability
• Greater potential for capital appreciation
• Last priority in liquidation

Preferred Shares:

• No voting rights at meetings
• Predetermined and stable dividends
• Priority protection in insolvency
• Limited growth potential

Preferred shares: Predictable returns in volatile markets

Preferred shares function as financial hybrids, combining features of debt and equity. Their dividends, usually fixed or with a pre-established rate, offer predictability in turbulent markets.

Variants of preferred shares

There are multiple modalities tailored to different strategies: cumulative preferred shares allow unpaid dividends to accumulate for future periods; convertible preferred shares can be transformed into common shares under specific conditions; redeemable preferred shares are repurchased by the company; and participating preferred shares link payments to financial results.

Rights and financial hierarchy

In the event of company bankruptcy, preferred shareholders recover capital before common shareholders but after creditors and bondholders. This intermediate position makes them defensive investments, especially sensitive to interest rate changes.

Advantages and limitations

Advantages: Attractive dividends in low-rate environments, relative security, predictable income flow.

Disadvantages: Limited appreciation potential, limited liquidity, lack of corporate influence, risk of dividend suspension during crises.

Common shares: Growth in exchange for volatility

Common shares represent business ownership with full rights but higher risks. Common shareholders participate in strategic decisions and benefit from corporate growth.

Types of common shares

Some companies issue non-voting shares, generating profit participation without voting influence. Others implement multi-class structures, allowing specific groups to maintain control with less ownership stake.

Rights and positioning

Common shareholders vote at meetings, determine directives, and claim assets in liquidation after creditors and preferred shareholders. Their dividends vary with performance, offering higher returns in good periods but exposing them to losses during recessions.

Profiles and characteristics

Advantages: High liquidity, significant appreciation potential, corporate influence, market transparency.

Disadvantages: Extreme volatility, inconsistent dividends, risk of total loss, exposure to economic cycles.

Comparison: Preferred shareholders vs. common shareholders

Investment strategy based on risk profile

For young investors with a long-term horizon: Common shares are ideal. The growth potential over twenty or thirty years far exceeds fixed returns from preferred shares, allowing for absorption of temporary fluctuations.

For investors approaching retirement: Preferred and common shares are strategically combined. Preferred shareholders generate stable income while common shareholders maintain exposure to growth, balancing security and return.

Recommended diversification: Mixing both types reduces overall volatility. A portfolio including preferred and common shares in proportions suited to your profile optimizes risk-return.

Market lessons: S&P 500 vs. preferred shares

The contrast between indices illustrates divergent behaviors. The S&P U.S. Preferred Stock Index, representing about 71% of the US preferred market, fell 18.05% over five years. Simultaneously, the S&P 500 increased 57.60%, highlighting how changing monetary policies affect both segments differently.

When interest rates rise, preferred shares depreciate (compared to bonds). When they fall, they appreciate. Common shares, linked to future corporate profitability, respond to broader economic outlooks.

Practical steps to get started

Choose a regulated broker: Verify credentials and competitive commissions.

Open an account: Provide documentation and make an initial deposit.

Conduct analysis: Study companies, sectors, financial ratios, and trends.

Execute orders: Use market orders (current price) or limit orders (predefined price).

Consider alternatives: CFDs on shares allow exposure without direct ownership, though with specific risks.

Monitor periodically: Review quarterly performance and adjust according to market changes.

Conclusion

Choosing between preferred and common shares is not binary but complementary. Preferred shares provide stability during turbulent periods; common shares offer growth in expanding contexts. A comprehensive strategy combines both according to life stage, risk tolerance, and specific financial objectives.